Scottish tax: Can meltdown be avoided?

12th Sep 2014

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When Scottish electors cast their votes in the independence referendum on 18 September, a ‘no’ outcome would result in greater devolution of tax powers to Holyrood. By contrast, a ‘yes’ result in support of independence would create the need for an entire new tax system for Scotland, says Donald Drysdale.

A pattern for greater fiscal devolution within the Union has already been set by plans for Land and Buildings Transactions Tax and Scottish Landfill Tax to be administered by Revenue Scotland, while the Scottish rate of income tax will be part of the UK tax regime administered by HMRC.

If this dual approach was extended as other tax powers were devolved, it could neatly balance the benefits of greater devolved powers with the economies of pre-existing UK-wide tax administrative systems. It could also help Revenue Scotland’s capabilities to develop in an orderly fashion over time, while relying on the existing strengths and expertise of HMRC.

The ‘yes’ option

An outcome in favour of independence would create the need for a comprehensive new tax regime for Scotland, with all the attendant administrative paraphernalia this would require. There would be an expectation, at least by those who had voted ‘yes’, that Scotland should achieve meaningful fiscal autonomy at an early date. They might be disappointed, of course.

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In its white paper of November 2013 entitled ‘Scotland’s Future: Your Guide to an Independent Scotland’, the Scottish government implied that the way forward after a ‘yes’ vote would be to replicate the UK tax system for a transitional period, with the potential for change in future.

The paper claimed that Scotland would then develop a tax system that was simple, neutral, stable and flexible (the potential conflict between those last two objectives was not addressed). The one-off costs of replicating the UK tax system and then moving to a simpler regime have still not been quantified and remain one of the worrying unknowns in the independence debate.

HMRC and Revenue Scotland

Taxpayers who come into contact with HMRC are only too aware of the administrative shortcomings of the existing UK tax system. Practitioners interacting daily with HMRC share the difficult pressures under which they work and are under no illusions – the tax regime is extraordinarily complex and virtually unworkable.

For years it has been apparent that Westminster MPs create tax laws without understanding their implications. In Edinburgh the situation seems even more acute, since Holyrood and its MSPs have virtually no tax experience and have already enacted new fiscal measures with insufficient debate. Replicating existing UK tax law that wasn’t fully understood in the first place doesn’t exactly sound like a cunning plan. Assuming that MSPs would also wish to flex their newly-won fiscal powers, even greater complexity might ensue.

Scotland’s population is one-tenth that of the UK. HMRC has 60,000 employees UK-wide, while Revenue Scotland employs only 30 permanent staff. In theory an independent Scotland with a fresh start should be in a position to introduce a simpler tax regime that could be administered by a leaner, more efficient tax authority. However, the task of replicating the UK tax system for a transitional period – presumably for several years – and then making fundamental changes on moving to a simpler regime would put enormous pressures on Revenue Scotland and require disproportionately high manpower.

In the meantime Revenue Scotland might be tempted to strengthen its tax expertise by poaching existing HMRC staff currently located in Scotland – of which there are some 8,000 – to administer Scottish taxes. However, this wouldn’t work. HMRC operates specialist UK-wide teams centralised in different locations across the UK. For example, national insurance is administered from Newcastle. Many of HMRC’s personnel north of the border are devoted to narrow processing roles. By contrast, most of HMRC’s senior technical and policy positions are in London – including oil and gas specialists whose expertise Scotland would require.

Perhaps HMRC might be asked to administer some aspects of the new Scottish tax regime for a time as a sub-contractor. By way of illustration, it has already been agreed that HMRC will administer the Scottish rate of income tax which will be set by Holyrood. The Scottish government is to pay some £40m for the necessary IT system, and around £4.5m annual running costs. Assuming that this particular public sector IT project doesn’t go belly-up (as so many of them do), this arrangement might work successfully within the UK following a ‘no’ vote.

Such sharing of responsibilities might not be feasible under independence. After all, divorcing couples are not generally known for their amicability. In reality, Westminster and Holyrood would be obliged to thrash out the best deals for their respective constituents at a time when they would be at loggerheads on a host of other crucial issues.

It may also be useful to ask what incentive there would be for HMRC to undertake such a sub-contract assignment. They are being pressed to reduce manpower, and their personnel are suffering from low morale. If HMRC needed to be incentivised by a highly remunerative contract, then this would be yet another cost forced on the Scots by independence.

Conclusion

Scotland is at a tipping point from which there will be no return. Regardless of the outcome of the referendum, the Scottish Parliament and Revenue Scotland have heavy responsibilities to ensure that the systems for tax administration are robust and cost-effective. It is unclear whether they will meet expectations.

Practitioners whose clients have interests in Scotland are likely to face many uncertainties in coming months, and will need to ensure that they are well informed about new Scottish tax developments as they arise.

Donald Drysdale is series editor of Bloomsbury Professional’s Scottish Tax Series, which aims to provide tax advisers and non-experts with practical and concise information on the Scottish and UK tax rules affecting taxpayers in Scotland.

Replies

It's the same type of people who currently sit in Scottish parliament as at Westminister. Indeed some in the Scottish parliament actually had a real job prior to politics. Alex Salmond (of whom I am no fan) was an economist. And George Osborne was what?

With a YES result, these Scottish MPs will no doubt want a new seat in an independent Scottish parliament. The same pool of talent/fools is available to both parliaments. As for professional input - have you been to Edinburgh? You can't move for accountants. I'm sure the ICAS will be able to contribute some advice on taxation.

I welcome the plans to replicate UK taxation whilst looking to improve and simplify the process.

Well said. The problem really is that the UK tax system has developed in to a totally uncontrolled shambles. All efforts to simplify the administration are thwarted by the system itself mushrooming seemingly out of control. This has resulted in HMRC not being able to control the payment of taxes. Companies and individuals who become insolvent and go in to liquidation or bankruptcy seem to owe staggeringly high amounts to HMRC.

The situation in Scotland would seem likely to be even worse now and if they obtain fiscal independence then will become much worse due to their increased complexity and lack of any systems.

1. If there are 60,000 HMRC staff and £Xm of HMRC systems in the UK then Scotland is due a % of this. If calculated on relative populations then it would be around 10% if calculated on other factors it could be more or less. rUK would have to pay Scotland to retain all their investment in UK tax collection operations? Possible that this would offset the Scottish "subcontracting" to rUK HMRC cost?

2 the fact that the 8,000 HMRC jobs in Scotland are determined to be low level jobs compared to England says a lot for how the UK Government has viewed previous investment to develop the national skills base of Scotland.

Your language gives you away - you are in the No camp. However, while you paint a poor picture of HMRC policy on direct and indirect taxes you make no suggestions as to how in the face of a yes vote the tax structure could be improved. Many of the tax rules are a direct result of a cross over between tax planning and outright tax avoidence which I believe most readers here would agree is a real threat and not just from multinational global concerns. The EU and HMT's understanding of tax rules have caused serious difficulty and caused the tax payer a huge amount of money in court costs. You can moan all you like about the tax system but what would you do to improve it?

@RustyI have no idea to whom that comment is adressed I don't think many of us are interested in composing a new tax code for Scotland or even rUK at this time maybe after the result people can have their 2p worth

A yes vote is currently 22% likely which is just ridiculously high given the "We'll just take a punt on that" nature of the SNP view of just about all of the big questions.

One thing most Yes voters are overlooking is that a Yes vote will mark the start of a massive game of poker with regard to the negotiations, this tax issue is just noise compared to the big stuff like defence and currency.

This is a poker game where one player - rUk- holds 90% of the chips. Due to the spiteful and poor quality nature of the debate as perceived from south of the border, the guy holding 90% of the stack will have hob-nailed boots firmly strapped on.

It does not take a rocket scientist to see who wins this game of poker.

A yes vote is currently 22% likely which is just ridiculously high given the "We'll just take a punt on that" nature of the SNP view of just about all of the big questions.

One thing most Yes voters are overlooking is that a Yes vote will mark the start of a massive game of poker with regard to the negotiations, this tax issue is just noise compared to the big stuff like defence and currency.

This is a poker game where one player - rUk- holds 90% of the chips. Due to the spiteful and poor quality nature of the debate as perceived from south of the border, the guy holding 90% of the stack will have hob-nailed boots firmly strapped on.

It does not take a rocket scientist to see who wins this game of poker.

The only real chip that an independent Scotland has to play is whether or not to walk away from their share of the debt. But we already know that they will play it when sterling isn't shared with them. So I can't see them being given any stuff like Typhoon jets or frigates that were financed with debt. Indeed, if it flies, floats or moves then it will go south.

As I said in another post, 2 years after a Yes vote, I think many Scots will be angry at Alex Salmond for making lots of promises that he couldn't keep and angry at rUK negotiating very hard with Scotland during the transition process.

If the Scots think they can use the UK tax system then move to an easier Scots system they are living in cloud cuckoo land.

Assuming a Yes vote, and after a nightmare divorce, Scottish MP's will want to social engineer behaviour as much as UK MP's and introduce added complexity to an already complex system.

A total shambles awaits.

On a separate point we have many clients in Scotland. I spoke to 2 of them last week, both high net worth and both going to move back to England regardless of vote outcome. They both said they fear where Scotland is gong to get it's tax revenue from and don't wish it to be them.

Of course if it's a NO they can continue to subsidise the Scots under the Barnet agreement and devo max.

Corporation tax in the UK is 20% and 21%, in Ireland it is 12.5% and 25% (per Wikipedia), what will it be in Scotland, the SNP advise they are going to adopt a low tax policy, how will the UK and Ireland react, I think a race to the bottom will commence, which will in turn mean more in direct taxes.